Even in 2018, some home buyers have enough money to make a big down payment on a home, but many do not. Many first time home-buyers in particular lack equity in another property and cannot make at least a 20% down payment. And if you cannot swing putting 20% down, you need to become familiar with mortgage insurance.
Mortgage insurance is usually required for borrowers who are unable to put down at least 20% on a home. Mortgage insurance is required by most lenders because if you want to borrow a lot of money and do not have a large down payment, the bank is exposed to more risk. People who do not put down big down payments are more likely to default on the loan.
With private mortgage insurance (called PMI with conventional mortgages and MIP with FHA mortgages), you pay extra money up front and each month to pay for insurance that will cover most of the loan balance if you stop paying. With this type of assurance, the lender can lend money to borrowers with smaller down payments.
Mortgage insurance helped the last financial downturn from being even worse; it is estimated that 11% of mortgages in effect in 2007 to 2010 were at least 30 days late, and millions of homes did eventually foreclose. That’s one of the reasons why many banks and lenders do not offer the no PMI loan.
Convention Loans and Mortgage Insurance
If you are getting a conventional mortgage and have less than 20% down, you must get PMI. The premium that you pay will vary based upon the loan to value of the property and your credit score. Whether the loan is fixed or variable also will affect the rate. The more money that you can put down, the less you will need to borrow and the less you will pay for PMI.
Your PMI is tied to the LTV, so the amount you pay monthly will slowly decline as you build more equity. Building equity simply means you are paying off some of the loan over time and you own a bigger percentage of the house.
The good news with PMI, while a necessary evil for many borrowers, is that it can be cancelled once you have reached 78% of the home value or sales price, whichever one is less. The bank is required by federal law via the Homeowners Protection Act of 1998 to cancel the insurance. If you believe your home value has increased, you could negotiate for PMI to be cancelled earlier. But you will probably need proof in the form of a new appraisal to convince the lender.
But do not rely on the lender to let you know when you can cancel PMI. As you can probably guess, many lenders will drag their feet in cancelling PMI. The bank will make more money off you if you continue to pay for PMI past the 22% equity mark. So, be proactive and keep tabs on how much equity you have in the home. When you are approaching 20% equity, contact the bank and let them know you expect that they will cancel PMI soon.
FHA Loans and MIP
Mortgage insurance for FHA home loans is similar but a bit different. You need to pay for the mortgage insurance premium up front and an annual mortgage insurance premium that is paid each month as part of the mortgage payment. FHA mortgage insurance is more expensive than conventional, but at least you pay the same amount regardless of your credit profile.
One thing to know about FHA mortgage insurance is the date June 1, 2013. If your loan was closed after this date, you must continue to pay mortgage insurance for the life of the loan. The only exception is if you put down at least 10%. In this case, MIP can be cancelled after 11 years. Yes, this policy sucks. That is why once you have at least 20% equity, you should strongly consider refinancing your home loan into a conventional loan so no mortgage insurance is needed. However, if interest rates have risen since you closed your FHA loan, you may not want to do this. You would be wise to keep an eye on mortgage rates and when they are at least .5% below your FHA rate, you may want to consider a refinance. It is absurd in our view to pay mortgage insurance premiums when you have far more than 20% equity in the home.
VA Loans – Good News
If you have a VA-mortgage loan, you have a great deal. Not only can you get 100% financing and rates even lower than FHA: You also do not have to pay for mortgage insurance! There is a one time funding fee for the loan up front, but no monthly mortgage insurance payment.
The bottom line is that mortgage insurance is a necessary evil for many Americans. But once you have 20% equity, you should either request it be cancelled, or refinance out of your FHA loan into a conventional so you no longer are paying that extra pesky payment each month.